Forms of direct and indirect taxation

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Financing central government spending

Taxation is the main method of financing government spending.

Types of taxation

  • Direct taxes
    A direct tax is paid directly by the person or business on whom the tax is imposed

    Examples:
    - income tax, 
    - capital gains tax, 
    - corporation tax, 
    - inheritance tax.

  • Indirect taxes
    An indirect tax is collected by an intermediary from the person who ultimately bears  the economic burden of the tax

    Examples:
    - VAT, 
    - tax on cigarettes, alcohol

    A retailer would be  responsible for collecting and paying these taxes to the government (ie the retailer is the intermediary), but the Consumer bears the burden through higher prices.

Direct taxation can be:

  • Proportional tax

    - average rate of tax is the same at all income levels, 

    eg 20% income tax for all levels of income.

  • Progressive tax

    - the rate of tax increases as income increases so that a higher proportion of total income is paid as tax by the better-off.

Indirect taxation is likely to be a regressive tax

It is a tax that takes a higher proportion of a poor person's salary than of a rich person's. 

For example, in the UK the television licence fee (the annual licence fee people have to pay in the UK to watch television) is an example of regressive tax since the fee is the same for all people. 

Sales taxes (such as VAT in the UK) are also regressive because they take a greater  proportion of the income of low income workers.

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